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By Ronald J. Sylvestri, Jr.

The days when Wall Street was dominated by characters out of a Tom Wolfe novel are long over. The “master of the universe” types and the clean cut, exercise crazy schmoozers have been replaced by a new breed of analysts. Now the brokerage houses and investment banks are full of hard-working men and women who put in long hours, crunching numbers and examining spreadsheets until the wee hours of the morning.

They’re still lifting weights, but the workout routine is intellectual and experiential, focused on cold, hard cash and asset gathering. The financial world has changed since the crash. Our relationship to capital is different now than it was before the whole system almost went over like a child’s set of dominoes.

Or has it. Interest rates are at all-time lows, with no end in sight. The largest asset managers remain big, almost too big to fail and continue to grow. Meanwhile the smaller guys continue to struggle. The real question is not how do we bring the market back, but how are the so-called big players still operating at such a massive scale?

The “Barbell” of Capital Introduction: Tackling Both Ends of the Spectrum

Asset management firms have taken a page out of the books of the companies in which they invest. They are starting to look a lot more like than Tiger Management. The key components of the new management style - product integration, consolidation, distribution, and branding -- are a major focus for firms that not too long ago prided themselves on their secrecy and anonymity.

It’s through brand-building and consolidation that these firms are implementing a “barbell” approach to raising capital: Targeting traditional multi-million dollar investors such as pension funds and endowments while offering products to retail investors at the same time. It’s not a split focus so much as it is a way to divide the risk while increasing the potential for rewards. Money managers are now forging relationships with retail platforms, Registered Investment Advisors, and in some cases even with individuals directly. For an industry that once prided itself on its adherence to tradition, this new approach constitutes a major change in the institutional money management game.

Going a step further, firms have learned to consolidate investment strategies and types into one distribution network. Private equity firms are adding hedge fund-like strategies to their portfolio of offerings and vice versa. Blackstone and Apollo, titans in the private equity industry, both now offer private equity investment funds alongside hedge funds, and funds of hedge funds.

Blackstone, which has its origins as a traditional private equity fund, now has real estate, hedge funds, a credit platform and closed end funds. Apollo now has private equity, real estate, and credit. It just recently bought Stonetower, a U.S. credit/CLO platform. Highbridge just closed a $5 billion mezzanine debt fund. Carlyle now offers credit, real estate and mezzanine debt investments as well.

The bottom line? All of these new products are aimed at enhancing distribution.

The Distribution Barbell

The culture of the asset management industry used to rest on a higher fee, “pay for performance” culture. The objective was to drive “capacity driven” strategies that generated expected returns within a given “assets under management” range. Upon breaking that threshold investors could no longer expect the same level of returns.

Today, just five years after the crash, the top ten private equity firms control $500 billion in assets while the top 50 control almost $1 trillion. At an average of $50 billion per firm, “capacity” is no longer even part of the vocabulary!

This new approach produces additional advantages for institutional investors as well as money managers. Investors can now gain access to multiple products through the same asset manager. This is the reason whyhedge funds remain in as much demand as ever. Net asset inflows reached $3.4 billion in 4Q, bringing total 2012 inflows to $34.4 billion, according to Hedge Fund Research. There were 9,810 hedge funds and fund of fund allocators in 2012, up from 9,575 in 2011 and from just over 9,000 in 2009. Investors continue to demand hedge funds as a source of alpha, but are increasingly seeking attractive risk-adjusted returns outside of the normal stock-based investing strategies.

This is where the retail investor enters the picture. The market has progressed far beyond the days when individual investors could only buy and sell on the stock exchange. Today individual investors can buy Limited Partner positions in private equity and hedge funds through any number of vehicles. They must be “accredited,” which is defined by the SEC as investors with a net worth of over $1 million, an annual income of at least $200,000 or a household income of over $300,000, but the pool of potential actors in the marketplace has broadened considerably under the new rules – and to everybody’s potential benefit.

Fees Come Full Circle

As the distribution mechanisms diverge, so too do the fee structures and liquidity terms. Average management fees for hedge funds are today just 1.5%, compared to a comfortable 2.0% prior to 2008 and even 3.0% back in the 1990s. Mutual funds offering these investment vehicles are also able to charge hedge fund-like fees, compared to a traditional management fee of as low as 0.1% for simple funds, to as much as 1.0% for more complex funds, with no performance fee attached.

With fees converging, it is no surprise firms are leveraging brands to expand across multiple platforms. There are additional advantages to offering more products to institutional investors as well. Large investors can make an “omnibus” investment into a multi-asset firm, which can then allocate that investment across platforms. When the name of the game is distribution and bandwidth, more and more alternative asset manager platforms are structuring products and vehicles that address all investors shape and sizes.

To attract these types of investors, Masters of the Universe must speak to each of us individually, another significant change from the past. As a result, large investment management firms have changed the way they fundamentally do business. Carlyle, for example, recently lowered the minimum threshold on a recently launched buyout fund, and lowered the lock up (the period of time prior to which an investor can access their capital) from a very unfriendly 10 years to just 2 years. These are unprecedented terms; terms the private equity industry has previously never seen.

Is all of this good for investors? Yes. Smaller audiences now have access to the same type of investments that have been traditionally only been offered to sophisticated investors. These asset classes are further down the risk spectrum, however. Private equity firms in particular utilize leverage to acquire controlling stakes in privately held companies. Hedge funds utilize leverage in ways that can accelerate both an uptick and drawdown of returns.

Importantly, these types of vehicles are not for everybody. But in the long run, greater access will benefit end investors, providing them with more investing alternatives and uncorrelated return streams. We may not be far off from a supermarket of investments that customers can walk into, scan their choice, and “check out” with a new fund. Shhh – don’t tell the managers.

Ronald J. Sylvestri, Jr. is the President of Quail Ridge Asset Management.